Mercury General Corp

NYSE:MCY

Earnings Call Transcript 2019-Q2

[Operator]

Good day. My name is Ian and I will be your conference operator today. At this time, I would like to welcome everyone to the Mercury General Second Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions].

This conference call may contain comments and forward-looking statements based on current plans, expectations, events and financial and industry trends, which may affect Mercury General's future operating results and financial position. Such statements involve risks and uncertainties which cannot be predicted or quantified and which may cause future activities and results of operations to differ materially from those discussed here today.

I would now like to turn the call over to Mr. Gabriel Tirador. Sir, please go ahead.

[Gabriel Tirador, President and Chief Executive Officer]

Thank you very much. I would like to welcome everyone to Mercury’s second quarter conference call. I’m Gab Tirador, President and CEO. In the room with me is Mr. George Joseph, Chairman; Ted Stalick, Senior Vice President and CFO; and Chris Graves, Vice President and Chief Investment Officer.

Before we take questions, we will make a few comments regarding the quarter. Our second quarter operating earnings were $0.74 per share compared to $0.88 per share in the second quarter of 2018. The deterioration in operating earnings was primarily due to an increase in the combined ratio. The combined ratio was 98.3% in the second quarter of 2019 compared to 96.9% in the second quarter of 2018. The combined ratio of the quarter was negatively impacted by $9 million of unfavorable reserve development, $9 million of catastrophe losses, primarily from Midwestern storms and a $3.4 million increase in accrued expenses as a result of an adverse appeal court ruling related to a California Department of Insurance non-compliance matter.

The $9 million of unfavorable reserve development in the quarter was primarily due to an increase in our loss adjustment expense estimates for defense and cost containment expenses in our auto California lines of business and also includes $3 million of unfavorable reserve development from prior year's catastrophe losses.

Excluding the impact of unfavorable prior year reserve development, catastrophe losses, ceded reinstatement premiums earned and increased accrued expenses related to the adverse appeals court ruling, the adjusted combined ratio was 95.5% in the second quarter 2019 compared to 92.6% in the second quarter of 2018.

For states outside of California, the combined ratio deteriorated which contributed to the increase in the company-wide combined ratio for the quarter. For all lines of business outside of California, we posted a combined ratio of approximately 108% in the second quarter of 2019 compared to 92% in the second quarter of 2018. Earned premium for both periods was approximately $130 million for states outside of California.

Our homeowners combined ratio was 102% in the second quarter 2019 compared to 95.3% in the second quarter of 2018 and contributed to the company-wide deterioration in the combined ratio. The California homeowners combined ratio was negatively impacted by an increase in loss estimates related to the significant California rainstorms that occurred during the first quarter of 2019.

Our year-to-date accident year combined ratio for California personal auto is approximately 95%. For California personal auto we recorded a low single-digit reduction in frequency trend and a mid single-digit increase in the severity trend.

In California a 6.9% personal auto rate increase in California Automobile Insurance Company was implemented in March 2019 and a 6.9% personal auto rate increase for Mercury Insurance Company was implemented in May of 2019. Collectively these represent two-thirds of company-wide direct premiums earned.

Approximately a 32% of the California Automobile Insurance Company rate increase was earned during the quarter and only 10% of the Mercury Insurance Company rate increase was earned during the quarter. In addition a 6.9% rate increase in our California homeowners line was approved by the California Department of Insurance with an implementation date of August 2019. We also recently filed for another 6.9% rate increase in our California homeowners lines of business. The California homeowners premiums represent about 12% of direct company-wide premiums earned.

The expense ratio was 24.4% in the second quarter compared to 24.3% in the second quarter of 2018. The slightly higher expense ratio was primarily due to the $3.4 million increase in accrued expense related to the adverse appeals court ruling, partially offset by a decrease in acquisition costs, primarily from lower average commissions and cost efficiency savings.

Premiums written grew 6.6% in the quarter primarily due to higher average premiums per policy and an increase in homeowners policies written. We recently completed our catastrophe reinsurance treaty renewal effective July 1, 2019. The total reinsurance limit purchased increased from 205 million in the prior period to 589 million for the July 2019 through 2020 period. Our retention increased from 10 million to 40 million. Total annual premiums on the new reinsurance program are approximately 38 million.

For the prior reinsurance treaty total premiums were 40 million including $18 million of reinstatement premiums. More details of the catastrophe reinsurance treaty renewal will be included in our second quarter 10-Q filing.

With that brief background, we will now take questions.

[Operator]

[Operator instructions]. Our first question is from the line of Greg Peters from Raymond James. Greg?

[Greg Peters, Raymond James]

I had a couple questions for you. First around the reserve development. I was going through my record of your results over the last 20 years and it seems like if we narrow it down for the last 10 years, you've had unfavorable development in eight of the last 10 years. And with all the rate increases and all the changes, that sort of stands out, because most companies tend to report favorable development. So can you give us some perspective of -- obviously, you talked about severity issues but can you give us some perspective of how that might change in the future?

[Gabriel Tirador, President and Chief Executive Officer]

Well, I think we've said before that we feel, especially in the bodily injury line, that there's been a changing environment. And how that might change in the future is we’ll be more conservative with respect to selecting more recent factors, as opposed to averaging factors for a longer period of time. So that should help with any adverse reserve development going forward. I will say that for California PPA that loss reserve development this quarter was pretty much non-existent and it was really on the defense and cost containment line or expenses where we're seeing increased litigation and we decided to increase our reserves for defending bodily injury claims.

[Ted Stalick, Senior Vice President & CFO]

This is Ted. One of the biggest issues we've had in the past has been with the California bodily injury coverages as far as the development goes, and obviously for the first half of this year our actual versus expected incurred loss development has essentially been in line. So it's developed pretty much how we expected it to when we set reserves at year-end. And I know it's just two quarters, but this is something that we haven’t experienced in the last couple of years where it actual has been higher than expected. And so it does give us some indication that the increasing loss development factors that we've seen over the years have now sort of stabled -- become more stable, and we're going to see better stability in those reserves.

[Gabriel Tirador, President and Chief Executive Officer]

Having said all that, Greg, we're obviously not happy with the reserve development that we've had eight out of 10 -- out of the last 10 years. But the rationale is what we just gave you.

[Greg Peters, Raymond James]

I certainly appreciate the things around litigation are moving target. And so I just was -- it just stands out, it's unique because most of your peers tend -- have a tendency to go through shorter periods of adverse development. And then they find neutrality or favorable development. But in the -- in your opening comments, you called out the $9 million of -- what you called out -- pardon me, you called out the unfavorable reserve development. And what I was trying to understand is, does that include the piece that you mentioned for catastrophe losses from prior years?

[Ted Stalick, Senior Vice President & CFO]

Yes. So the $9 million has with it attached $3 million from catastrophe losses from prior year, which was primarily from the Woolsey Fire, the partial losses have developed more than we expected. The one thing I’ll point out is the Woolsey event, the losses were -- we had exhausted our reinsurance limit within that layer. And so, any development on the Woolsey was not covered -- with additional 3 million were now into the next layer and if there’s any future development on prior year cats those will be fully covered by reinsurance.

[Greg Peters, Raymond James]

Thank you for that clarification. Can I pivot for another line of questioning around your -- the disclosure around your new catastrophe, your property cat program. And I think in your comments -- on your limit -- your total limit is up what substantially like twice as much as what you purchased before. So I'm just curious what -- obviously your experience last year, call it your perspective there but this is all going to come at a cost too and then the quarterly retention is moving from 10 to 40. So if we were to replay the quarterly results last year, how many quarters would we hit that $40 million retention?

[Gabriel Tirador, President and Chief Executive Officer]

If we were to replay…?

[Ted Stalick, Senior Vice President & CFO]

The Camp Fire obviously was well excess of a 100 million, so that would have hit that. And the Woolsey Fire is in the low 40s. So a piece of that would have hit it, the car fire was about 20 million.

[Gabriel Tirador, President and Chief Executive Officer]

Yes, Greg. We just felt that the pricing for the 10 to 40 was just too high. It was just -- it does not make an economic sense from our standpoint to purchase that layer.

[Greg Peters, Raymond James]

Yes, I totally understand what you’re saying. And so it seems like going forward the exposure on a net basis to cat losses will go up. And if I'm to read through your comments, the cost does the reinsurance. The new program relative to last year is only up modestly or is there a different perspective on cost?

[Gabriel Tirador, President and Chief Executive Officer]

Well, it’s up modestly if we consider the reinstatement on premiums. But the reality is that the cost -- the rate increase -- there is sizable rate increases in each layer, pretty sizeable rate increases in each layer. But when you compare what we actually ended up paying, last three period is about 40 million and I think the new treaty is about 38 million.

[Greg Peters, Raymond James]

And that 40 from last year includes 18 million of reinstated limits?

[Gabriel Tirador, President and Chief Executive Officer]

Right.

[Ted Stalick, Senior Vice President & CFO]

This 18 million of what?

[Greg Peters, Raymond James]

Reinstated limits?

[Ted Stalick, Senior Vice President & CFO]

Yes.

[Greg Peters, Raymond James]

So without that, it’s 38 compared to 22?

[Gabriel Tirador, President and Chief Executive Officer]

That’s hard to analyze because the retention change and we obviously bought a lot more limit on the higher end.

[Greg Peters, Raymond James]

Right. And you mentioned in your comments that you will have more detail around this in your 10-Q. So would be able to pull out the cost et cetera that will be easy for us to identify?

[Gabriel Tirador, President and Chief Executive Officer]

Well the total cost will be in there.

[Ted Stalick, Senior Vice President & CFO]

I think the more detail is going to be around how the layers work and the exclusion within those layers.

[Greg Peters, Raymond James]

Okay, well I don’t want to [hog] up your conference call time, but it will be great to have a follow on conversation offline on this topic, just to make sure I have everything set up right. The last on the questions, I realize there’s another analysts that would probably want to ask questions. So it seems like the California business is doing well but the non-California business is not. Is there anything -- is your perspective changing on business outside of California now or do you still have same strategy going forward?

[Gabriel Tirador, President and Chief Executive Officer]

We have a same strategy going forward. Outside of California current year today results have been disappointing. In the quarter, we had quite a few large losses in the quarter that contributed to the results. We had increased severity. We had some Midwestern storms. On an accident year basis through June of this year, the 2018 accident year is running 97 but the ‘19 is running like at 102.5. So a lot of that has been driven right now by Florida and Georgia. We're continuing to analyze what's going on there from a severity standpoint. We also have some changes that we're going to be implementing in Florida and Georgia. I think Florida in September and in November, for Georgia from a segmentation standpoint that we think will help both on the growth side and also on the profitability side.

But last year we had a really good year outside of California. I think we -- for PPA we recorded the calendar year combined in the 93, 94 range if I’m not -- if my recollection is right in an accident year as I mentioned for ‘18 is about 97. So we have some work to do though outside of California and especially in some of these states to improve the results.

[Operator]

And our next question is from the line of Christopher Campbell from KBW.

[Christopher Campbell, KBW]

First, I’m going to ask you on the core loss ratios. It sounds like there you are having some issues in like Florida and Georgia and some of other states. But if you are looking at the core loss ratio, that was about 200 bps year-over-year. So I mean how much of that -- was any of that like one-time event or is that more attritional, how should we think about that? How should we think about modeling that going forward?

[Gabriel Tirador, President and Chief Executive Officer]

Well, I mean I think from my perspective at least for PPA outside of California like I mentioned earlier we think we are running at about 102 right now. We have some changes and there is lot of volatility outside of California sometimes from quarter-to-quarter. I will say that. I think in California PPA, we think we're running at about a 95% on a year-to-date basis. We have a lot of this 6.9 that we haven't earned, most of that has not been earned. We see frequency going down a couple of points and severity going up mid single-digit. So there should be some margin expansion in our California PPA line going forward absent any kind of reserve development. So that’s how I would view it.

[Ted Stalick, Senior Vice President & CFO]

Yes. I would say the one-time, so the -- Gab mentioned there’s $3.5 million expense charge that was a result of this appellate court ruling. So that's clearly not going to happen every quarter. And then the homeowners -- California homeowners was elevated in the first quarter. In California, we had a significant amount of stormy weather. And there was about 4 million of additional reserves from the first quarter that we put up in the second quarter just related to that kind of stormy weather event. So that's now pretty much closed out. So you could probably figure there's a little bit there too.

[Christopher Campbell, KBW]

And then just looking at California lines, so I think, Gab you’d said in the script low single-digit -- losing low-digit increases in frequency and then mid-single-digit increases in severity. Is that right?

[Gabriel Tirador, President and Chief Executive Officer]

Yes. Reduction in frequency, reduction. I think you said increase, reduction …

[Christopher Campbell, KBW]

Okay. Got it.

[Gabriel Tirador, President and Chief Executive Officer]

Yes, yes. And mid-single-digit increase in severity, yes.

[Christopher Campbell, KBW]

Perfect. So all-in, so should we be thinking like low to mid-single-digit, loss cost inflation in that line?

[Gabriel Tirador, President and Chief Executive Officer]

That's what we're thinking.

[Christopher Campbell, KBW]

And then you have the 6.9, basically you said only 10% of that earned in the second quarter. So we have like 90% of that to come?

[Gabriel Tirador, President and Chief Executive Officer]

Yes. For Mercury Insurance Company, which is our biggest sub and then Cal Auto had about 32% of it earned.

[Christopher Campbell, KBW]

And then are you guys planning on taking any more auto increases in California or you guys think you’re done for the time being?

[Gabriel Tirador, President and Chief Executive Officer]

I think we're done for the time being.

[Christopher Campbell, KBW]

But you are taking another 6.9 and you are just filing for another 6.9 in California homeowners, correct?

[Gabriel Tirador, President and Chief Executive Officer]

Yes. And the 6.9 goes into effect in August and we filed for another 6.9 in California homeowners. Yes.

[Christopher Campbell, KBW]

And then just pivoting to net investment income, so pre-tax net investment income growth was a little bit weaker than I expected. So that’s only up like 70 bps versus kind of that mid to high-single-digit premium we've seen over the last year. So I guess just why was the growth so soft this quarter? And then how should we think about projecting the net investment income going forward, especially as rates are starting to come down?

[Chris Graves, Vice President & Chief Investment Officer]

Hey, Chris. It's Chris Graves. Well, I thought the growth was actually pretty good, especially year-over-year. But we've seen -- the last year we positioned ourselves to be much more sensitive -- and actually looking at prior year as well, to be much more sensitive to the rising low interest rates from the fed. And that really boosted investment income. And of course that’s come to an end. The curve is flattened on us, inverted in part, leaving us with a few real interesting fixed income opportunities.

So in light of the structure of the yield curve broadening our duration quite a lot, I think there is considerable amount of risk out on the yield curve. So, going forward, it's going to be a tough environment, and I think it's going to last well through the rest of this year and good part of 2020 as well. So I don’t know if we’ve -- the company is growing -- the underlying growth is good, are seeing growth in the investment portfolio. That’s going to continue to push investment income higher if everything else stays the same. But it’s hard for me to tell you exactly where we’re headed now.

[Christopher Campbell, KBW]

Okay, got it. That’s very helpful. Thanks Chris. And then maybe one for Ted. Operating tax rate was a little bit lower than we had expected. Any color on anything special that was happening and how should we think about modeling this going forward?

[Ted Stalick, Senior Vice President & CFO]

Well I think it was lower because underwriting income was lower than you modeled. So underwriting income is, tax is roughly 21% and investment income’s tax is roughly 10% or 11%. And so when the mix of those changes it changes the overall effective tax rate.

[Operator]

[Operator Instructions]. Our next question line of Jay Cohen from Bank of America. Jay?

[Jay Cohen, Bank of America]

Yes, just a couple of questions. During the call you suggested a more conservative loss pick, I think it was for auto BI, just I mean already put in place or just I mean you have to contemplate going forward or maybe I misheard it?

[Gabriel Tirador, President and Chief Executive Officer]

No, what I was referring to is when we select linked ratio factors, generally we would select maybe an average of going back four quarters, eight quarters as an example but we’re weighting more -- the more recent ratio factors which produces a higher amount. So that’s what I was referring to Jay.

[Jay Cohen, Bank of America]

I guess looking forward over the next four quarters that by itself all else being equal puts a little bit of upward pressure in the loss ratio?

[Gabriel Tirador, President and Chief Executive Officer]

I don’t -- I mean we’ve already done that, so I'm not sure why would put up -- or unless it’s worse than we’ve picked.

[Jay Cohen, Bank of America]

Well I guess because you’ve had some of this adverse development that’s what I thought but I guess it came from other areas so it’s not such a big factor. I guess the other question with the price increases, how are you finding the reaction in the market? It feels as if you’re being a bit more aggressive than others in raising price and is there some competitive blow back because of these increases?

[Gabriel Tirador, President and Chief Executive Officer]

Yes, I would say that our new business applications are down quite a bit actually, in California for the quarter they were down about 20%. But what’s happening too is the quoting volume is down quite a bit, our quote volume was down about 16% year-over-year for the quarter.

So as a result and our new business is down as a result of both the 6.9 increase that we took and quoting volume. Now if you take away the quoting volume, our forecast was pretty much in line, a little bit better than in line with respect to what we thought the new business and our retention would end up at. But the quote volume really had an impact.

[Operator]

And at this time, I'm showing that we have no further questions on the line. I’d like to turn the call back to the presenters for any closing remarks.

[Gabriel Tirador, President and Chief Executive Officer]

I would like to thank you all for joining us this quarter, and we look forward to speaking with all of you next quarter. Thank you very much.

[Operator]

Ladies and gentlemen, this does conclude today's conference call. We thank you for your participation. You may now disconnect.